Investing in stocks is what most people think of when it comes to investments, and owning shares in good companies with a proven track record can indeed be very profitable. The stock market lends itself both to long-term investments and trading – short-term ownership of stocks whose price go up or down in days or weeks. The price of a stock going down does not sound like a great investment opportunity, but through “short selling” it can be quite rewarding for the knowledgeable investor.
Stock Market Chart
The FTSE is the most popular stock market index in the UK. Note that you can edit the ticker symbol to make this chart show whatever stock or index you wish.
Stock Market News
How to Get Access to the Stock Market
Can you imagine a situation where over one million beginners like you who want to trade the stocks listed on the New York Stock Exchange or the American Exchange, or some other global exchange that is open to traders from across the world, gather on the trading floor in person and start trying to buy stocks from other traders who have been in the market for years, numbering in the millions? It would be total bedlam. How can anything be done in the cacophony of voices, ensuring that no sharp practices occur and the trading is done in an orderly and timely fashion? That would just not be possible. That is why a system was created where traders who wanted to trade stocks had to go through a representative company, or individuals who work in such representative companies, as a means of harnessing traders into one place where their trades, money and the entire process could be managed in an orderly fashion. These representative companies could then come to the market place and meet other representative companies that also house clients like you, and they could now buy shares from, and sell shares to each other on behalf of all their clients. For this service, you would only be required to pay a token to that representative company. That was how the concept of stock brokerage was developed.
Nowadays with hundreds of millions of traders worldwide participating in stock exchanges around the world, stock brokerages represent the access point to the stock market. So the first step in starting the journey of trading stocks is by opening an account with a stock broker.
There are two types of stock brokers operating in the market today. We have:
a) Full-service brokers who provide an array of value-added services in addition to the conventional ‘buy and sell for me’ services rendered by brokers. They provide investment advice, portfolio management and sometimes, privileged news delivery services regarding virgin investment opportunities and market moving information. Their services are quite pricey, and for this reason, only those with a sizeable amount of cash can afford their services. These brokers also have a minimum benchmark for account opening balance, usually starting with thousands of dollars.
b) Discount brokerages offer stripped-down brokerage services. The unique selling proposition of discount brokerages as pioneered by Charles Schwab and others, is the very low brokerage fees that range from $4.95 to $9.95 per trade, irrespective of the number of shares being traded. However, this puts the onus of the extra services such as investment research solely in the hands of the trader. Discount brokerages allow traders open cash accounts for as low as $500 and $2,000 for cash/margin (leveraged) accounts. There are many discount brokerages and a search for them on the internet search engines will yield a plethora of names.
Requirements for Stock Trading
Having capital to trade is only one of the requirements. Traders must present documents to prove their identity and also to show where they live. These requirements became necessary after the September 11, 2001 attacks showed a lot of terrorist money being moved by third party/proxy accounts. So the fight against money laundering and financing if terrorism has been moved a notch by requiring all traders to be identified as the bonafide owners of the accounts that they trade with, and that the money they use for trading does not come from illegal sources. To this end, traders must present a drivers’ license/international passport/national ID card as proof of identity, AND a bank statement/utility bill as proof of residence. Some countries have also gone a step further to require that brokers operating citizens-only brokerages collect information concerning taxation status and residency status.
Furthermore, a trader will need to equip himself with the tools of the trade. A computer/smartphone and access to the internet are must-haves for every stock trader. Traders must also have an acceptable means of depositing funds and withdrawing funds from the stock trading account. A credit/debit card, domiciliary account for wire transfers or an e-wallet account such as Skrill are acceptable methods of transaction.
How Stocks are Traded
A stock can be traded by a long position, aiming to profit when the stock appreciates, and to a restricted extent, traded by short-selling the stock with the aim of profiting from a drop in price. Various methods of analysis are used to predict the movement of the asset.
In a nutshell, this is what a beginner who wants to trade stocks needs to know about the stock market. The actual business of buying and selling stocks is outside the scope of this article, but the information is accessible on other sections of this site.
Fundamental Stock Analysis
- What is the present market value of a stock in relation to a rational and objective valuation of the company’s performance and prospects?
- Is the present price of a stock representative of its actual value? In other words, is a stock presently undervalued, truly valued or overvalued on the basis of its present market price?
- Will a stock’s price correct itself to match its intrinsic value?
So the whole idea of using fundamental analysis is to determine the relationship of the present price of a stock and its intrinsic value, determine if the price matches that intrinsic value, and determine when the price will correct itself to match the intrinsic value depending on the circumstances and news items surrounding the stock in question.
The following data are used by traders when deciding on whether it is worthwhile to invest in a stock or not.
The earnings season is a period which the markets take very seriously and is one that traders and investors look forward to. This is when the earnings reports are released. The earnings report not only tells investors how much money a company has made or lost, but also gives traders the following information:
- Earnings per share
- Price earning ratio (P/E ratio)
- Net income
- Net sales
The price-earnings ratio is especially important in measuring the valuation of a company. The lower the P/E ratio of a company, potentially the better the valuation of that company. A very practical way of looking at a company’s valuation using the P/E ratio is to compare it with that of other companies listed in the same sector.
Earnings reports are released every three months, i.e. every quarter. They enable investors and shareholders to gauge the financial status of the companies in which they have investments in, and also in companies in which they may have an interest in investing in. The numbers seen in the earnings are not considered on their own, but are rather weighed against past numbers to see if there is improvement in financial performance or a decline. For instance, a company may release a report stipulating that they recorded a loss, but if the loss was much less than in previous quarters (as was with Blackberry’s Q2 2012 report), investors will interpret this as a sign of changing fortunes and we will see demand on the stock. On the other hand, if profits declared miss estimates (as was seen in Google’s and Apple’s Q3 2012 reports), demand will drop as investors offload the stocks of these companies. Google’s stock fell 10% on the day its disappointing Q3 report was released.
So investors can on the basis of the earnings reports, decide whether to pull out from a company, or put money into a company or even increase the existing stake that they have in the company, and these factors will affect the share price of the company.
Introduction of a New Product
Certain companies are known by their products. Talk of Apple and immediately people think about the iPhone, iPad and iPods. No one really associates Apple with their TVs or with any of their other products. The iPhone and iPad are the flagship products of Apple as a result of the revolution these products created in the world. They changed the way we make calls and use the internet. As such, anytime an upgraded iPhone or iPad comes up in the market, we see sales going through the roof and investors scrambling for the shares of Apple as a result of the perceived valuation of the company in the near future. The Apple story is a clear example of how the introduction of a new product that creates a human revolution can change the financial outlook of that company, and is so doing, determines its valuation as perceived by investors.
Mergers and Acquisition
Mergers and acquisitions have the same valuation effect on a company’s stock. If a struggling company is acquired by a much more powerful company, there will be an improved valuation on the shares of the acquired company. On the other hand, a merger between a strong company and an extraordinarily weak company can have a negative valuation on the shares of the former.
A government policy can radically change the perception of stocks in a particular sector, and increase the valuation and intrinsic values of the affected companies. When the US Supreme Court upheld most of the provisions of the Affordable Care Act of 2012 (Obamacare), the stocks of Medicaid HMOs such as Molina, Amerigroup and Centene soared while those of health insurers dropped because of the income expectations that the law would have on both sets of companies. Health insurers would incur more costs by covering people with certain preexisting conditions, as well as compete with state-based insurance exchanges for clients, which could negatively impact their finances. On the other hand, Medicaid HMOs would be able to make more money from the increased number of clients in the system. This is just one example of how a government policy could change the valuation of a company.
It will take some practice to fully understand how to use these parameters in fundamental analysis. The trader can practice this by looking at historical instances and applying them to present-day situations on a stock trading demo account in order to fully master the technique of trading stocks with fundamental analysis.
Guide to Short Selling
Short selling in the financial markets means borrowing an asset such as a stock from a broker to sell them at a high price, and then buying them back when prices have fallen so as to return the asset to the broker, and benefiting from the price differentials.
Short selling is used when there is an expectation that the price of an asset will fall within a space of time. Traders generally carry out short selling to make money from falling prices or they use it as a hedging strategy to protect themselves from fall in prices on assets in which they have long positions.
Short Selling as a Hedging Strategy
For instance, a trader may be long on an imaginary stock we shall call XYS, and he may then decide to short sell the stock options on XYS. The strategy is played in such a way that if XYS has a bullish run if the trader is long on it, and the short sale option is out of the money as a result, then the cost of the short sale loss will be far less than the outcome of the long trade on the stock. But if the price of XYS drops and puts the long position in a losing position, then the gains to be made from the short sale will far outstrip the loss on the long position on XYS. In this scenario, short selling XYS will act as a hedge trade.
Short Selling in a Falling Market
Traders can decide to employ short selling as a strategy to gain from falling prices, especially when the fall in prices is a systemic problem and not restricted to a sector or a single stock. This is why in the weeks following the collapse of Bear Stearns and preceding the collapse of Lehman Brothers in 2008 (the events that triggered the global financial crisis), traders massively engaged in short selling of stocks, especially those of the financial sector because they were all in a predicable free fall.
However, there is a very thin line to tread when trading a systemic fall in prices, because it gives room for spreading of negative rumours and when everyone is selling, it tilts the equilibrium of the markets. Regulators will always step in when this occurs, and we have seen bans on naked short selling at various times when there is systemic crisis. So if a trader wants to short sell as a profit strategy, then the best bet is to identify individual or sectorial assets based on technical and fundamental analysis, and short sell those assets with a bearish outlook.
Conditions for Profiting from Shorting
Short selling is an extremely risky strategy. If you are familiar with the collapse of MF Global, a financial services company that short sold the Euro in expectation of a fall in the value of the single currency in a massive bet that went horribly wrong, then you can imagine how risky the strategy is. A trader can lose a lot of money in an instant.
For a trader to be able to profit from short selling, the following parameters must be met:
1) The trader must be able to locate an asset to use for short selling. To do this, the trader must have a trading account that provides enough margin for short selling, and also permits short selling.
2) There must be enough liquidity in the asset to enable the short seller get buyers of the asset at the market price.
3) The price of the asset in question must experience a price drop to put the trade in a profit.
4) The trader has to be able to buy them back at a lower price.
5) The asset in question must not be one restricted from short selling by the regulatory authorities.
Short selling is a very good way to trade a bearish expectation for an asset. There are many emerging market exchanges that only permit stock purchases, and traders can only make money from bullish runs. Trading in these markets can be frustrating because opportunities to make money are restricted. But with short selling, a trader’s opportunities to make money even from falling assets are limitless.
A good example of a profitable short sale was that performed by George Soros’s Quantum Hedge fund which made more than $1billion in profit by short selling the British Pound in September 1992. Another trader who made money shorting a market is doctor-turned-investor Michael Burry, who made more than $600 million from short selling the credit default swap instruments on the US subprime housing market. Economists like Nouriel “Dr Doom” Roubini have regularly predicted periods of market crashes (he predicted the housing market bubble in 2005, long before prices began to tank), and such analyses easily form the basis for making huge profits from falling markets.
Short selling is also very useful for hedging and protecting profits. As was illustrated earlier in this article, short selling is a tool that allows traders to make up any losses incurred on the asset from unprofitable long positions. Many hedge funds who were long on stocks and stock markets used shorts to cover these positions and were able to use it to come out relatively unscathed when the cards came crashing in 2008.
How A Trader Can Make Money from Short Selling
A good target for a short sale would be an asset which is heavily overbought and whose fundamentals are not in tandem with its high prices. A good example of this was seen in an emerging market in Africa, where the breweries subsector was experiencing a massive price boom. There were questions over the state of health of some of the breweries whose stock prices were enjoying this sectorial boom, and a concerned investor decided to visit one of such breweries. He met overgrown weeds, a non-functional plant, a few workers and dilapidated structures. With this information, he quietly exited his holdings and within a short time, the information came out and the stock tanked. Such fundamental analysis is what is used to make informed decisions on what asset to short sell.
There are also technical indicators to consider. Is the asset forming a top or a bottom? There are several ways of identifying tops, bottoms, continuations and reversals on the charts. These can be used as a basis for short sale. A short seller would be looking to sell a market top or a bearish reversal pattern.
The market bias of traders is partly influenced by market news, some of which are facts and some of which are rumours. Nothing causes market panic more than negative rumours. Part of what fuelled the systemic collapse of global stock markets in 2008 was fake market rumours following the collapse of Lehman Brothers. Many traders would enter short selling positions in certain assets, then float negative rumours to force the asset price to tank so as to profit from these moves. From there on, it was a season of short selling which served to collapse the market further. You can get an idea of how this works from the film Casino Royale, where the villain of the movie tried a terrorist attack on a new-design aircraft hoping to profit from the collapse of the airline’s shares (which never happened thanks to 007).
This and other unethical practices led to a ban on naked short selling by many regulatory bodies across the world. Today, several degrees of restrictions on short selling are still in place. So if you want to practice short selling, you need to be conversant with the rules in your jurisdiction so as not to run foul of the law.
Day Trading Stocks
Day trading is a high-risk – and potentially high-reward – practice of buying and selling stocks over limited periods of time, such as during the same day, to take advantage of short-term price fluctuations. While risk will always be part of the day trading equation, the most successful day traders have the discipline to craft a plan and stick to it. By following a few simple steps, you can significantly increase your chances of turning a profit on your day trading activities.
Profits on day trading can often be significant – but expect most of your trades to yield smaller gains. That means you do not want a pay-per-trade system eating into your profits. Establish an account with an online trader that offers unlimited trading and does not charge per transaction. You may make dozens of trades over the course of a day, and per-trade fees can add up quickly.No matter which exchange you trade on, there are too many companies for you to track knowledgeably. As a day trader, you should look to become an expert in one thing – whether it is energy providers, small cap companies, or companies trading below book value. When you narrow your focus you are much more able to spot opportunities, and you will spend much less time making uninformed and unprofitable trades.
Learn the trading habits of the stocks you choose to follow, and look for any large trades or momentum. An initial spike in trading volume often leads to additional spikes as other investors jump on the bandwagon. If you can spot spikes early, you can get in on the ground floor as the stock increases in price. Some day traders trade on momentum, such as positive press coverage, rosy economic forecasts, or optimism around a particular industry. The best day traders will spend hours before markets open pouring over news and looking for companies that have or may gain momentum that could lead to stock price increases.
You will lose money sometimes. If you are uncomfortable with that notion – or if you do not have the money to risk – you should avoid day trading and focus your investment efforts on opportunities with less volatility. Too many day traders make losses much worse than they need to be because they will not accept that they have lost money on a trade. For example, you may purchase 100 shares of an energy company because you believe it will receive a favorable bump from a report on rising home heating oil prices. Instead of the bump, the stock loses half a point. Clearly your assumption was wrong, and now is the time to sell and minimise the damage. But many day traders will continue to stubbornly hold the stock, and will compound their losses.
A little bit of greed is good in day trading, but too much greed will wipe out your capital quickly. No stock increases in value forever, and you have to resist the temptation to retain a high-performing stock for too long. Once a trade has made you an appropriate profit, based on your expectations and the rules you have established, have the discipline to sell the stock before it begins to slide. Every now and then you may miss out on an opportunity to realise additional profits – but more often than not, you will save yourself from a painful loss